There needs to be some way to find an appropriate amount of spending. The realistic amount lies somewhere between a 3% glide path and a 10% path to destruction. What if you put your own fears aside—of telling clients they may have to take a pay cut in a disastrous market—and instead paid a bit more attention to what is possible.
There are no right answers to spending policy decisions. But to be clear, we are the ones writing the rules. If clients need to keep pace with inflation, drop the initial payout. If the objective is to ensure that our clients will never run out of money in any scenario, drop the initial payout. If we want to own way fewer equities, drop the initial payout. If there’s no inheritance, drop the initial payout. We can come up with a whole host of reasons and ways to ensure that our clients will never outlive their money. But what if we thought about things differently?
What if we wanted our retired clients to spend more money while they had the health to enjoy it? What if we allowed them to pick how much of their assets they could leave to children or charity? What if we didn’t pay as much attention to inflation because we were more concerned about increasing their spending today?
Every decision we make is based on a model, not a map. A model describes what could happen, but not what is. So if you change the model, you change what could happen. The question is, how can you change the model in a way that is still responsible, but allows for more money to be spent sooner?
What we have used over the last several years (even from 2008 through today) is a model that answers the question, “What is the most that I can comfortably spend, knowing that if things collapse, I will take a pay cut?”
We use the traditional Monte Carlo simulation with thousands of iterations. We pick a success rate at 93%, which means that even though we are trying to get as much money into our clients’ hands as soon as we can, most of the time they are going to have far more money than what they had intended. It excludes certain assets—real estate, for example. We take a three-year portfolio average, which means that during a bull market the portfolio value we use is muted; during a bear market, it is enhanced. We don’t adjust for inflation; we increase cash flow based on portfolio returns. We drive down fixed expenses so our retirees can afford to cut their “pay” if need be. And we take an advance on certain things that we have the choice of delaying—pension income or Social Security. We set aside cash based on market valuations. All of these things raise the chances of success to a level in which our clients can spend more of their portfolios than traditional measures would allow. A different question results in a different answer.
Whose Risk Is It Anyway?
November 3, 2014
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Comments
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Thank you, Ross, for sharing these stories. Thank you also for sharing so many details of how you handle these real world situations. I own/manage a small firm (200 households/$140 million AUM) and have also had to work through many of these kinds of challenges. (Real world is always so different than the academic studies!) Your article is an encouragement to me, as it confirms much of what we've been doing. Thank you for being a beacon for our profession.
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This may work fine in the laboratory or on the computer, but it ignores the one guaranteed and mandatory expense in retirement - Medicare! If you earn too much of the wrong type of income your modified adjusted gross income (MAGI) rises. Rising MAGI could mean you pay more for Medicare premiums because surcharges are based on MAGI. Pay more for Medicare, and you get less or zero Social Security. That means you have to come up with more net after tax income to replace SS. That could cause higher taxes and further principal reductions. Good luck trying to recover that in an unknown market.